Beginner's guide to: Interest rates

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The Independent Online

What is the Bank of England base rate?

The base rate – or official bank rate – is the interest rate at which the Bank of England lends to other banks overnight. In turn, it influences the interest rate at which banks will lend to individuals and companies, and the rate of interest that they will pay savers on deposits. Currently, the bank rate is 4.5 per cent.

How does the Bank decide to set interest rates?

The Bank's main objective is to keep inflation at around 2 per cent. Broadly speaking, if inflation rises above its target, the Bank will raise interest rates, and vice versa. Raising interest rates helps to lower inflation, by forcing consumers and businesses to pay more on their borrowing, and therefore spend less elsewhere. And when less is being spent, prices of goods and services are less likely to rise.

Why are mortgage rates higher than the bank rate?

The bank rate is an overnight interest rate. Longer-term lending rates tend to reflect lenders' expectations of future bank rate movements. Hence, if lenders think the bank rate will fall, their longer-term lending rates may be slightly lower than bank rate. Over the last year, however, this has not always been the case. Because banks are wary of lending to each other, they are charging much higher longer-term rates, and are consequently being forced to also charge much more for their mortgages. So even though the bank rate is expected to fall over the coming months, the cheapest two-year fixed rate mortgages are almost 1 percentage point above the base rate.

Why are savings rates higher than base rate?

Banks are struggling to raise the money they need to continue lending, so they are offering much higher savings rates to attract more money from individuals. Two years ago, it was unusual to see savings accounts paying more than 0.5 percentage point above the bank rate. Today, the best rates are more than 2 percentage points higher.

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